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Pet Parents Flock to PETsMART

Leading pet specialty retailer posts solid third-quarter numbers.

My wife rarely lets me pick out pet food anymore, knowing that invariably I will select something inexpensive from the shelves of Wal-Mart(NYSE:WMT) or Target(NYSE:TGT) rather than a premium brand from a store such as PETsMART(NASDAQ:PETM). Considering both my dog and cat will eat whatever is in their bowl, or in the other's bowl, or on my plate, the added expense seems unnecessary -- but, despite this compelling logic, increasing numbers of "pet parents" are shopping at the specialty retailer anyway.

Yesterday, the Phoenix-based company met expectations by posting a 20% increase in third-quarter earnings to $0.24, or $35.9 million, on revenues that rose 13% to $826.8 million. Same-store sales advanced 6.7%, following a solid 7.5% gain a year ago. Management bumped up full-year guidance slightly and is now forecasting earnings of $1.19-$1.20, which would top estimates and represent a 25% increase over the $0.95 earned last year.

PETsMART's selection of chew toys, treats, aquariums, and other accessories is broad enough to please even the most discriminating pet owner. It is pet-related services, though, not products, that has shareholders begging for more. Though they accounted for only about 7% of 2003 revenues, premium services -- such as in-store grooming, training, and boarding -- are the fastest-growing and most profitable component of PETsMART's business.

For the quarter, sales in this segment rose 23.5% to $57.8 million and year-to-date have grown by more than $35 million to $178.3 million. Expect this growth to be further augmented by full-service "pet hotels" in the near future. The company has only a handful of these currently but is anticipating that 12 more will be rolled out next year, and ultimately as many as 270 will be in operation nationwide. Not surprisingly, rival Petco(NASDAQ:PETC), who is scheduled to report third-quarter results after the bell today, has also integrated pet services into its stores.

Not only has PETsMART consistently posted strong top-line growth, but also margin expansion is one trick that this company has down pat. During the third quarter, gross margins improved 72 basis points to 30.5% -- marking the 14th straight quarterly gain for that measure. Nevertheless, the company still trails Petco, who last quarter reported gross margins of 34.6%.

Maintaining an edge in premium pet services will be a key challenge for PETsMART. Not only is this high-margin, fast-growing segment likely to be an earnings driver going forward, but it will also help increase store traffic by attracting customers that might not shop there otherwise. Of course, while they're waiting for their pets, it never hurts to pick up an extra bag of food -- a premium brand, naturally.